A Word about the Price Action in FX

In the wake of the FOMC meeting, the US dollar has softened, especially against the euro and sterling. Both currencies have moved above the recent caps near $1.36 and $1.70 respectively.   What was resistance, should act as support, if the breakouts are to be sustained.

The euro has already reached about $1.3645.  The next immediate targets are the 200-day moving average near $1.3667 and the post-ECB high near $!.3677.  

Technically, at the end of last week, it appeared that the euro would be pushed through the $1.3500 support area and retest the year's low near $1.3477. Instead, since Monday, the euro has been recording higher lows and higher highs.

Using the Commitment of Traders in the CME futures as a guide, the short-term speculative market appears to have been caught wrong-footed.  Since the middle of March through last Tuesday June 10, the gross speculative short position has risen from less than 65k contracts to over 100k.  The gross short position was the largest in over a year.  Similarly, the gross long positions have been culled from 111k contracts in early May to less than 44k contracts as of June 10.

The FOMC meeting confirmed that the trajectory of US monetary policy has not shifted due to either the sharper than expected contraction in Q1 GDP, or the tick up in inflation, or the rally in the equity market and other risk assets.  This has seen a resumption of the European peripheral bond and stock market rally that had appeared to have stalled in recent days.   There has also been talk of Asian central bank purchases of euros.

We also note reports that the Greek bond market, yes the Greek bond market, is drawing some of the largest institutional investors.  A recent Bloomberg article lists the operators:  Prudential Financial Inc has been buying Greek bonds with 5-year or less maturity.  Jupiter Asset Management has been increasing its holdings since October.  Fidelity Worldwide Investment has been accumulating a long Greek bond position over the past six months.   Invesco, Blackrock and Legal & General Investment Management also own Greek bonds, according to the report.

Since the ECB meeting earlier this month, the Greek 5-year yield has fallen by nearly 75 bp while the 10-year yield is off a little less than 55 bp.  By way of comparison, the Italian 10-year yield is off a little more than 10 bp, of which half has come in the aftermath of the FOMC meeting.  Spain's 10-year yield is off 17 bp, a third of that decline is taking place today.

The demand for sterling is sufficiently strong that even a soft retail sales report was not enough to prevent the investors from taking sterling to new multi-year highs.  It rose above the August 2009 high seen near $1.7043.  The next objective is around $1.7145-65, where the 120-month and 520-week moving averages are found.  Above there is the $1.7330 area, which corresponds to a 50% retracement of the drop from the 2007 high near $2.1160.  

We note that the UK is the only major country that has seen 10-year yields rise over the past three months. The yield pick up over euro area bonds continues to increase.  Investors in UK bonds are attracted to yields, with little chance of significant capital gains.  This is a different strategy than buying peripheral bonds for some yield pick up (over the core), but playing more for capital appreciation.  

The UK 2-year yield is twice the US yield.  It has not moved above Portugal's 2-year yield as well.  In a world of relatively low interest rates, it is increasingly expensive to short sterling.  We suspect part of sterling's rally has been fueled by a capitulation of short sellers.  The Commitment of Traders report showed that gross short sterling positions rose 25% in the past month to their highest level since February.  The gross long position may be more than the gross long euro, Swiss franc and yen position, but as of June 10, it was still off the multi-year posted in April.  

With US 10-year Treasury yields pushing back lower from the brief transgression of the year's downtrend, the dollar is trading heavier against the yen as well.  Yen weakness is not blunting the euro's strength, and the net effect of this is that the Dollar Index has broken back below its 200-day moving average (just below 80.30).  It has already retraced 38.2% of its May through early June rally.  The next retracements are found a little below 80.00 and then 79.70.   As one might expect, the short-term technicals indicators, like RSI, and MACDs have turned down and the 5-day moving average is slipped below the 20-day average for the first time since mid-May.